Small States in World Politics
2-6-2020Floris Hagel, s1847511
Eerste lezer: Dr. W.P. Veenendaal
Tweede lezer: Prof. dr. Ingrid van Biezen Woorden: 7996
The Mediterranean Dream and the
Scandinavian Nightmare
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Inhoud
INTRODUCTION ... 2
THEORETICAL FRAMEWORK ... 3
RESEARCH PUZZLE AND EXPECTATIONS ... 6
RESEARCH DESIGN ... 8 RESEARCH METHOD ... 13 DATA ANALYSIS... 14 CONCLUSION ... 28 BIBLIOGRAPHY... 30 APPENDIX ... 36
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INTRODUCTION
Iceland gained independence in 1944 and Malta in 1964. These small countries were two of the poorest states in Europe at the start of 20th century, yet their economic development was
remarkable. All around Europe small states thrived. While these states profited from more openness, they also became more dependent on import and export for their success.
Consequently, they became more and more vulnerable to an economic shock. A great economic shock that puts this vulnerability to the test presented itself more than a decade ago. This was the most severe economic crisis the European Union (EU) had ever experienced.
While most Scandinavian states weathered this recessional storm relatively well, almost all states in the Mediterranean saw a large economic downturn. Nevertheless, for both regions there were small but interesting exceptions. The small Scandinavian Icelandic economy almost collapsed during the economic crisis with a GDP decline of almost seven percent in 2009, but the small Mediterranean Maltese economy remained relatively untouched with only a two and a half percent decline in 2009 (World Bank, 2019). A great diversity can be observed between small states and this diversity raises important questions on why some small states almost went
bankrupt, while others remained untouched. Asking these questions and finding suitable answers can help small states build resilience for the next economic crisis. Therefore, the goal of this thesis is to gain a better understanding of the reasons why such a difference can be observed in economic resilience between small states.
This thesis is structured as follows: First, it will discuss relevant literature about small state economies, it will outline the research puzzle of this thesis and then draw expectations based on existing literature. After this it will discuss the variables that are going to be analysed in this thesis, it will then explain the chosen research design to answer the research question and clarify the case selection. It will then discuss the research methods that are going to be used in this thesis. This section is followed by a section dedicated to analyses of the data. After that it will draw conclusions and implications based on the analysis.
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THEORETICAL FRAMEWORK
Small states in the international economy
Most traditional growth theories, like the Classic Lewis model, are founded upon a number of assumptions. The Classic Lewis model emphasises the critical role of industrialisation and the labour transitions from the large low-productive agricultural sector to a large-scale industry sector (Lewis, 1955). For this development to happen there is need for a large population, a large agricultural sector and a large agricultural labour force (Armstrong & Read, 2003, pp. 102-103). As such, it seems clear that the model is generally not applicable to small states because of their small population size.
The economic challenges small states face are well documented in the literature (Streeten, 1993; Briguglio, 1995; Commonwealth Advisory Group, 1997; Easterly & Kraay, 2000;
Armstrong & Read, 2003; Fairbairn, 2007). First, they have a small domestic market that fails in achieving the necessary critical mass of production to be optimally efficient. They do not reach scale advantages because of a lack of domestic demand (Armstrong & Read, 2003, p. 103). Secondly, because of their small population they also have a very limited labour force (Armstrong & Read, 2003, p. 104). Thirdly, the small domestic market and limited supply of labour result in undiversified and specialised export, making small states depend on a limited number of economic activities (Armstrong & Read, 2003, p. 105). Lastly, the inability to produce a wide range of goods and services means that small states are dependent on import for many goods and services (Armstrong & Read, 2003, p. 105).
Despite the challenges that small states face, a high level of economic growth can be seen among a lot of them (Easterly & Kraay, 2000, p. 2014). Small states seem to be able to achieve economic prosperity, sometimes even outperforming their larger counterparts (Armstrong & Read, 2003, p. 110). A useful explanation comes from the endogenous growth theory (Grossman & Helpman, 1991). In this theory there are some critical variables for growth that are especially relevant for small states. One important variable for growth is openness of trade. A positive correlation can be seen between the openness of a country’s economy and economic growth (Edwards, 1998 p. 396). Because of their inability to produce certain goods and their reliance on import, small states need a high level of structural openness. For small states, international trade is the primary source of economic growth (Armstrong & Read, 2003, p. 111). Trade and
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openness give small states the essential means to finance imports and overcome many of their disadvantages.
However, this does not mean that openness and international trade only come with advantages. A lot of studies stress that the economic growth of small states seems to be paired with increasing economic vulnerability. The high dependence of small states on international trade makes them more vulnerable for exogenous shocks (Commonwealth Advisory Group, 1997; Easterly & Kraay, 2000; Armstrong & Read, 2003; Fairbane, 2007; Briguglio, Cordina, Farrugia, & Vella, 2009). The vulnerability arises because of their low diversity in domestic activities and their dependence upon external trade, especially imports. These two factors combined amplify the domestic impact of any external economic shock. Growth that relies on external sources and the resulting large trade multiplier1 means that small state economies, generally, are vulnerable to the destabilising effects of an external economic shock (Armstrong & Read, 2003, p. 108). But small states have another disadvantage according some of the literature, because their ability to respond effectively to exogenous economic shocks is constrained by their limited economic policy autonomy and their limited economic resources. As a result, they often do not have the long term means to smoothen the impact of an exogenous shock (Thorhallsson, 2018, p. 38).
Studies on economic vulnerability provide empirical evidence that small states are characterised by high degrees of output concentration and openness. The characteristic openness is certain to produce a high level of economic volatility, with periods of a high degree of
economic growth but also short periods of great economic downfall (Easterly & Kraay, 2000; Armstrong & Read, 2003). This seems almost inevitable according to the literature and yet, in practice, diversity can be seen in how small state economies react to economic exogenous shocks. Some small states seem to be more vulnerable to economic shocks than others while they enjoyed the same degree of openness and show similar high periodic growth rates (Briguglio et al., 2009, p. 231).
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Especially for small states potential gains from trade are enormous because of the magnitude of the trade multiplier. Small increases in trade have high growth effects (Armstrong & Read, 2003, p. 106).
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Small states and Economic resilience
The ability of a state to withstand the effects of an external economic shock is called economic resilience. In general, economic resilience is associated with actions undertaken by private economic agents or policy makers that help a country to withstand the negative effects of an economic shock (Briguglio et al., 2009, p. 230). While much is written about economic resilience in general, little attention is paid to small states and their economic resilience specifically, despite being interesting cases because of their presumed vulnerability.
There is, however, one important and classical study of Katzenstein (1985) on the
economic success and resilience of small European states. The study is based on seven European ‘small’ states2. States that may not be considered small in current times. The study does not
include smaller states like Malta or Iceland. It does, however, give useful insights on the resilience of small states in general. Katzenstein argues that these European small states can respond effectively to changes in the global economy due to their domestic structures (Katzenstein, 1985, p. 199).
Katzenstein (1985) argues that European small states strengthen their resilience with democratic corporatism and a social welfare system. For the existence of democratic corporatism there is need for a broad culture of political consensus within a state. It is furthermore positively associated with a consensus democracy (Lijphart & Crepaz, 1991). Corporatism is the
cooperative, voluntary regulation of conflicts over social and economic issues. These issues are discussed through highly structured political relationships between the state, trade unions and businesses (Katzenstein, 1985, p. 32). Democratic corporatism enables small states to respond swiftly and effectively to economic change with flexible policies. The main function of this policy is to help the economy adapt to the changing competitive order (Katzenstein, 1985, p. 63).
The social welfare system helps to overcome vulnerability in a different way. The
European small states complement their liberalisation of the economy with a strategy of domestic compensation (Katzenstein, 1985, p. 47). This policy is meant to counter the effects of external dependency by expanding control over the domestic economy. This happens through the
nationalisation of a part of the national income which is used for social and public spending. The social welfare system is designed to provide compensation for instabilities in investment and
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employment that are common in open economies (Katzenstein, 1985, p. 47).
Other literature identifies more important variables that improve economic resilience: social development, good governance and macro-economic stability. Social development enables effective functioning of the economy without the hindrance of civil unrest. Good governance is crucial for an economic system to function properly. Governance relates to issues such as government effectiveness, rule of law and security of property rights. Government effectiveness is needed for appropriate government intervention to manage the economy and foster economic resilience. Without mechanisms like the rule of law and security of property rights it would be relatively easy for shocks to result in economic unrest and social chaos (Briguglio et al., 2009, p. 236). Macro-economic stability relates to the interaction between the aggregate demand and supply of an economy. If overall expenses in an economy moved in equilibrium with overall supply, it shows that the economy is in balance. This is needed for a sustainable fiscal position (Briguglio et al., 2009, p. 235).
Another important factor that is positively associated with more resilient economies is a more diverse, export-oriented economy (Bristow & Healy, 2018, p 147). As discussed, small states generally do not have a very diverse economy and yet in some cases small state economies seemed resilient. This shows more shortcomings in the literature and the need for more research conducted on the topic of vulnerability and resilience of small states (Fairbairn, 2007, p. 137).
RESEARCH PUZZLE AND EXPECTATIONS
Research Question:
There are some gaps in the literature concerning small states, economic vulnerability and resilience. Many of the studies on small states and their economic vulnerability were conducted before the global economic crisis that started in 2008. This opens up an interesting field of research. While the literature on economic vulnerability suggests that almost all small states would suffer, in practice this did not happen. Although almost all small states were affected greatly, there were some exceptional cases where the economic crisis did not do as much damage as expected. The aim of this thesis is to analyse why a small state like Malta was not as
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specifically, this thesis tries to answer the following question: Why was Malta’s economy more
resilient to the external economic shock of 2008 than the economy of Iceland?
Expectations:
On the basis of the literature, several expectations can be developed that help to answer the research question. First, Briguglio et al. (2009) address the importance of good governance that is associated with economic resilience. It is necessary for an economy to withstand the negative impacts of an economic shock because it shows the government’s ability to manage its economy effectively. Without good governance it would be likely that economic shocks lead to economic and social turmoil. Hence, small states with good governance are expected to better withstand an
external economic shock (First expectation).
Secondly, Briguglio (2014) argues that social development is a crucial component of economic resilience. Social development shows the extent to which effective social dialogue is able to take place within an economy to create effective economic policy. With better social development, there should be a more effective function of the economic apparatus without the hindrance of civil unrest (Briguglio, 2014, p. 23). For this reason, a state with better social
development is expected to have more economic resilience against an economic shock (Second expectation).
Thirdly, Briguglio et al. (2009) discuss the importance of macro-economic stability for economic resilience. Macro-economic stability is necessary to maintain a sustainable fiscal position. With instabilities in employment rates and high inflation it would be hard to withstand the effects of a shock. Thus, a state with macro-economic stability is expected to have more
economic resilience against the impact of an economic shock3 (Third expectation).
Fourthly, Katzenstein addresses that vulnerabilities of small states can be compensated with domestic structures. Democratic corporatism enables small states to react swiftly and
effectively to an economic shock. Social welfare helps small states in managing their economy by compensating the risks that come with openness. Katzenstein expects that states that do not have
3 Macro-stability is the stability of the whole economic system within a country. It is something different than
economic resilience because resilience focusses on the ability of a country to withstand the negative effects of an economic shock.
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his model are more vulnerable. For these reasons, small states with democratic corporatism and a
social welfare system are expected to compensate their vulnerabilities and be more resilient against an economic shock (Fourth expectation).
Lastly, Bristow and Healy (2018), and many other studies argue that a more diverse economy is less vulnerable and more resilient. A concentrated economy is a common problem for small states. A state that heavily depends on a small variety of sectors should be less resilient than a state that has more economic sectors to depend on. Therefore, a small state is expected to
be more economically resilient if it has a diverse economy and does not depend heavily on one sector (Fifth expectation).
RESEARCH DESIGN
Conceptualisation and Operationalization:
Small state:
The most commonly used definition for a small state is based on population. The paradigmatic small state is one with a population of 1.500.000 or less, but perhaps with the recognition that it can include other cases if a good argument is made to do so (Commonwealth Advisory Group, 1997; Armstrong & Read, 2003; Sutton, 2011; World Bank, 2017). In economic terms,
population is a useful measure because it gives insights into the size of the domestic market and the labour force. Therefore, this thesis will use population as conceptual measure with the threshold of 1.500.000.
Economic Resilience:
Economic resilience is generally defined as the policy-induced ability of an economy to
withstand the negative impacts of an economic shock (Briguglio et al., 2009, p. 233). It should be noted that some of the indicators used to measure these variables overlap.
Social development is comprised mainly of the educational and health development of
every individual within a society. Social development is a crucial component of economic resilience because it enables good functioning of the economy without the hindrance of civil unrest in times of crisis (Briguglio, 2014, p. 22). Social development shows the extent to which effective social dialogue is able to take place within an economy to create effective economic
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policy. An indicator for social development is educational advancement. It can be measured by school enrolment ratio and mean years of schooling. Another indicator for social development is health. The life expectancy at birth is a useful indicator for measuring health within a society (Briguglio et al., 2009, p. 236). These indicators will be measured with the Human Development Index (HDI) that includes these indicators (United Nations Development Programme, 2019). When measurements like mean years of schooling and life expectancy are high, there is high social development within a society.
Good governance is crucial for an economy to function properly and to be resilient. Good
governance can be defined by way in which power is exercised in the management of a country’s resources for successful development (World Bank, 1993). It emphasizes the fair function of the rule of law, security property rights and effective governance. This paper will measure good governance with the Worldwide Governance Indicators dataset, which uses six indicators to measure good governance (World Bank, 2018b). 1) Voice and accountability 2) Political stability and violence 3) Government effectiveness 4) Regulatory quality 5) Rule of law 6) Control of corruption. States are ranked according to these indicators in percentiles 0 until 100. The higher the score of these indicators, the ‘better’ the governance.
Macro-economic stability is characterized by internal balance. It focuses on aggregated
quantities and the balance of an economy in general. Indicators of macro-economic stability are a healthy price inflation4, an unemployment rate close to the natural rate5 and the level of external debt (Briguglio et al., 2009, p. 236). These indicators are measured by unemployment and inflation ratios and the external debt to GDP ratio. These indicators will be measured through datasets of the World Bank that contain data of states and their external debt, inflation and unemployment rates (World Bank, 2019).
Democratic corporatism:
Democratic corporatism has three characteristics. First, an ideology of social partnership, shared by both business, unions and expressed in national politics as a consensus democracy. Secondly, a system of centralised and concentrated interest groups. Thirdly, the voluntary and informal coordination of conflicting objectives (Katzenstein, 1985, pp. 88-89). Existing indicators of corporatism measured the characteristics by 1) Political-economic consensus; political-economic
4 Generally speaking, an inflation rate of 2% is considered healthy. 5 An unemployment rate of between 4% and 6% is considered natural.
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consensus can be measured by good relationships between interest groups and the number of strikes in a state. A high amount of strikes indicates a low political-economic consensus, because good relationship between employer and labour organisations would not give the necessity to strike 2) Centralised interest organisations; measured by centralisation of interest groups. The existence of many interest groups, that represent, for example, the same occupation is an
indication for decentralised interest organisations. 3) Interest group participation in policy and a mediator role by the government; participation in policy can be measured by the structure of governmental decision making, if it includes interest groups. This indicator will be measured by the existence of a governmental council that includes unions, or other interest groups
(Kenworthy, 2003).
Social welfare system:
A social welfare system is a system in which the state plays a key role in the promotion and protection of the social and economic well-being of its citizens. Because this thesis will test Katzenstein’s theory it will use the states that have Katzenstein’s model as a measurement for a welfare state. It will compare social spending these states and compare them with the two cases to decide if they have a social welfare system. According to Katzenstein, Switzerland does not have a social welfare system, but Denmark, the Netherlands and Norway do.
Diverse economy:
The Herfindahl-Hirschmann index (HHI) is commonly used to measure economic concentration and diversity (United Nations, 2016, p. 13). It measures the extent to which an economy is dominated by several sectors. It ranges from zero to one, where the closer to zero a state scores on the index the more diverse the economy of a state is.
Research Design:
This thesis will apply a combination of two theories on two cases. The first one from Briguglio et al. (2009) about economic resilience of small states was written during the economic crisis. Therefore, it will be tested in a new context, namely the economic crisis. The second one is Katzenstein’s (1985) theory about democratic corporatism and a social welfare system that will be applied to two ‘smaller’ cases. The research is going to be of qualitative nature because this
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thesis seeks to gain understanding of the underlying reasons of why a difference can be seen in the impact of an economic shock in Malta and Iceland. The research uses a most similar system design (MSSD). This means that the cases that are selected for this research are similar on a wide range of explanatory variables, but are different on the dependent explanatory variable (Levy, 2008, p. 10).
Case Selection:
Table 1.1
GDP growth (yearly %)
Year Malta Iceland EU average
2007 4% 9,3% 3,1% 2008 3,3% 2% 0.5% 2009 -2,5% -7% -4,3% 2010 3,5% -3.4% 2.1% 2011 1,3% 1,9% 1,8% 2012 2,8% 1,3% -0,4% 2013 4,6% 4,1% 0,3%
Note. Adapted from the World Bank. (2019). Databank.
Table 1.1 shows that there is a huge difference in how these two small European states reacted to the economic crisis that started in 2008. Where Iceland had a seven percent decline in GDP, Malta only had a decline of two and a half percent in GDP in 2009. This was significantly less than the EU average. A short but huge economic crisis started in Iceland while Malta’s economy only had a short period of small economic decline. An obvious difference in outcome can be seen in these two cases but they also share a lot of similarities.
Table 1.2
MSSD: Malta and Iceland
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Small state Yes Yes
Developed Economy Yes Yes
Open Economy Yes Yes
Trade Dependent Yes Yes
X Yes No
Economic Resilience Yes No
These similarities can be seen in table 1.2. With Malta’s population of 500,000 and Iceland’s population of almost 370,000, there is no doubt about the classification as small state for both states. Malta and Iceland were both considered developed economies in 2008 (United Nations Department for Economic and Social Affairs, 2019, p. 169). Iceland and Malta show similar economic openness. According to the index of Economic Freedom the two states have similar open market scores in 2008, with Malta scoring 86 on Trade freedom, 50 on investment freedom, 70 on financial freedom and Iceland 85 on Trade freedom, 60 on investment freedom and 60 on financial freedom (The Heritage Foundation, 2020). Both countries were also considerably dependent on trade. A huge share of their GDP consisted of trade, especially compared to the world average. According to the World Bank (2019) the world average trade percentage of GDP was 60% in 2008. For Iceland this was 85% and for Malta 290%. This makes these two cases even more interesting because a high trade dependency is considered to increase vulnerability (Easterly & Kraay, 2000; Armstrong & Read, 2003).
An important difference that should be mentioned is European Union membership and adaption of the Euro. Malta became a member of the EU in 2004, it also adapted the euro in 2008. Iceland never became a member and it kept its own currency the Icelandic Krona. The decision not to join the Eurozone and the European Union could have greatly affected Iceland’s macro-economic stability and possibly its ability to withstand an economic shock.
In addition to these similarities there is another reason why these cases are selected for this thesis. Malta and Iceland are good representatives for developed small states. If it is true that the presence of variables associated with economic resilience where present in Malta and not in Iceland it could be expected that other developed small states were these variables are present also have more resilience against the next economic shock.
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RESEARCH METHOD
Methods:
To answer the research question this thesis will compare the states of Iceland and Malta on the following variables: social development, good governance, macro-economic stability, democratic corporatism, social welfare system and diversification at the start of the economic crisis to
determine which one caused resilience. This thesis will use a combination of two research methods for its analysis: Qualitive content analysis and semi-structured interviews.
Qualitative content analysis is a method for systematically describing the meaning of data (Schreier, 2014, p. 2). The method is flexible and it requires the researcher to focus on selected aspects of meaning that relate to the research question, and therefore it helps to reduce the
amount of material (Schreier, 2014, p. 2). The semi-structured interview is chosen because it is an excellent way to gather detailed information that is needed to answer the research question and to gain a better understanding on a topic.
Source Selection:
This thesis will triangulate by using a variety of sources and research methods to produce a more accurate, trustworthy and unbiased analysis (Thies, 2002, p. 359). Hence, this thesis will select a variety of sources and compare them. The sources for the qualitative content analysis will mainly be news publications, online databases, informative websites and government publications. Furthermore, it will use academic literature to triangulate if available. The sources must date from the chosen timeframe or contain information about that timeframe and the sources must contain information about variables associated with economic resilience.
News articles are an important source in the content analysis because they give useful insights that are necessary to answer the research questions. They can give valuable information about the existence of the variables, such as information on social unrest and the presence of national strikes. Governmental publications, online databases and informative websites are also valuable in this analysis because they can provide more important data about the variables. In
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particular, they provide useful information about the crisis, its impacts on different sectors and the composition of the economy.
The goal of the semi-structured interviews is to gain a better understanding of the existence of democratic corporatism and civil unrest in both states at the start of the economic crisis. To that end, an interview is conducted with two former chairmen of the similar
overarching labour organisation in both states. These board members both served at the start of the economic crisis. In Malta’s case an interview is conducted with former secretary general Tony Zarb from the Maltese General Workers Union. A similar interview is held for Iceland with former chairman Gylfi Arnbjörnsson of the Icelandic Confederation of Labour.
DATA ANALYSIS
The start of a global economic crisis
The trigger for the global financial and economic crisis was the ‘credit crunch’ that emerged in the end of 2007. It started when foreclosure and default rates went up, and real estate prices went down. The US housing bubble popped and brought the global financial structure crashing down in 2008. This plunged the whole world into a recession (Gamble, 2009).
The case of Iceland
The vulnerability of a small state economy has become evident in the case of Iceland during the economic crisis in 2008. From 1990 until 2007 Iceland showed impressive economic
development with a yearly average GDP growth of more than 3,5 percent (World bank, 2019). Important sources of economic growth for Iceland were fishery and aluminium but the largest portion of Iceland’s success rested on the super-fast growth of the financial sector. In 2008 the country came to an economic standstill when the global financial system collapsed and foreign trade crumbled (Thorhallsson, 2009, pp. 121). In 2009 Iceland’s GDP shrunk with almost 7 percent making it the worst year Iceland’s economy ever experienced. This shows that Iceland
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was not able to withstand the negative effects of an external economic shock. Therefore, Iceland’s economy was not resilient.
Social development & Civil unrest
In Table 1.3 can be seen that Iceland has a high level of social development. To determine if Iceland’s social development is high table 1.3 compares the indicators for social development, between Iceland and the European average. Europe has a considerably above average level of social development compared to other regions (Our World in Data, 2014). Table 1.3 shows that Iceland scored much higher on Life expectancy and school enrolment ratio than the European average. Therefore, one can clearly state that a high social development is present in Iceland.
Table 1.3
Social Development Iceland
Iceland: European
Average:
Year Life expectancy in years Mean years of schooling (Primary) school enrolment ration Life expectancy In years Mean years of schooling (Primary) school enrolment ration 2007 81,4 10,3 98% 75,1 10,9 94,6% 2008 81,5 10,4 99% 75,5 11,3 95% 2009 81,7 10,5 99% 75,8 11,7 95,3% 2010 81,8 10,6 99% 76,3 11,9 96%
Note. Adapted from The United Nations Development Programme. (2019). Human development Data (1990-2018)
Briguglio (2014) expectation is that small states with a high social development are expected to better withstand the negative effects of an economic shock, because a high social development is expected to have decreasing effect on the amount of civil unrest. A low amount of civil unrest enables a good functioning of the economic apparatus when a shock occurs (Briguglio, 2014, p. 23).
According to the Global Nonviolent Action base and Icelandic newspapers there was a lot of civil unrest in Iceland in 2008 until 2009, despite the high social development. The Global Nonviolent Action base recalls that at the height of the protest more than 10.000 people were
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involved (Global Nonviolent Action Database, 2012). This is more than three percent of Iceland’s total population, which is an impressive number. Articles from newspapers and news websites show that protests of this size were extraordinary in Iceland considering Iceland’s usually calm civil temperament (Iceland Review, 2008; The Guardian, 2009; IceNews, 2009a; IceNews, 2009b; Reykjavik Grapevine, 2013). A quote from Arnbjörnsson illustrates the seriousness of the civil unrest:
‘Icelanders can get angry and so forth but they normally don’t rally. What we saw in February and March 2009, you know, fires in the streets and so forth. This was something we have never seen before’ (Arnbjörnsson, 2020, min. 17:00).
The conclusion that can be drawn on these multiple sources is that there definitely was civil unrest in Iceland during the time of the economic crisis, despite the high social development. This suggest that Briguglio’s expectation is questionable that social development does not necessarily strengthen resilience in the way that it enables good functioning of the economy without civil unrest.
Good governance
Table 1.4 shows that good governance was present in Iceland at the beginning of the economic crisis. In fact, Iceland had one of the highest governance scores in the database that consists of 203 states (World Bank, 2018b). Before the crisis Iceland belonged to the top five percent for every indicator (World Bank, 2018b). With a decrease of political stability and regulator quality during the crisis, Iceland still scored far above average. Good governance was definitely present in Iceland.
Table 1.4
Good Governance Iceland
Year Voice of Accountability Political Stability Government Effectives Regulator Quality
Rule of Law Control of corruption
2007 96,2% 99,5% 95,5% 92,7% 97,1% 97,6%
2008 96,2% 96,6% 96,6% 87,9% 97,6% 99,5%
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Note. Adapted from the World Bank (2018b). Worldwide Governance indicators.
Macro-economic stability
Table 1.5 shows that Iceland’s Unemployment rate and Government Debt Total werestable. Before the crisis the unemployment rates were a little under the natural rate of four to six percent for more than a decade, and the Government debt total of GDP was below European average (Organisation for Economic Co-operation and Development, 2019). What is interesting is that inflation in Iceland was far above the natural rate for many years. In fact, the last year Iceland’s inflation rate was around the healthy rate of two percent was in 1998 (World Bank, 2019). The fast-economic growth and the economic crisis only made the inflation rate more unstable. The high inflation rate before the crisis show that Iceland was not macro-economically stable.
Table 1.5
Macro-economic stability Iceland
Year Unemployment Rate Inflation Government Debt Total %
of GDP 2005 2,5% 4% 38,2% 2006 2,8% 6,7% 43,9% 2007 2,3% 5% 40,7% 2008 2,9% 12,7% 77,9% 2009 7,2% 12% 96,9% 2010 7,6% 5,4% 102,4%
Note. Adapted from the World Bank (2019). Databank.
Democratic corporatism & A Social Welfare System
To examine if democratic corporatism could strengthen resilience there is need to determine if there was democratic corporatism in Iceland. The first indicator, political-economic consensus, is questionable in Iceland’s case. An interview with the former chairman of the Icelandic
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Confederation of Labour shows that there were a low amount of labour strikes in the period before the economic crisis (Arnbjörnsson, 2020, min. 01:00). The good relationship between labour organisations, employer organisations and the government did not make strikes necessary. However, the former chairman also said that Iceland is used to having a conservative government and labour unions cannot rely on a left-wing government to build welfare. Therefore, the trade unions play a large role in pressing the government into creating welfare for workers which can be an indication for less political-economic consensus (Arnbjörnsson, 2020, min. 04:00).
Interest group organisations play an important role in Iceland. They enjoy a high participation rate of around 90 percent and every type of occupation has its own organisation (Ólafsdóttir, 2020). However, local labour organisations have their own bargaining power and are independent from the bigger confederations, like the confederation of labour. The former
chairman said:
‘We are quite diversified in that aspect. Labour organisations in Iceland are quite diversified, there are many organisations covering local areas in a specific job type’ (Arnbjörnsson, 2020, min. 01:00).
This comment shows that labour unions in Iceland would not classify as centralised, specialised monopolistic peak organisations which is a characteristic for democratic corporatism.
Furthermore, in Iceland negotiations between labour and employer organisations are usually bilateral, but if there are any complications in negotiations someone appointed by the government and the interest groups can play an unbiased mediator role (Arnbjörnsson, 2020, min. 11:00). There is no fixed council or whatsoever that involves interest groups and the government into structured negotiations. It is evident that there was no democratic corporatism in Iceland when the economic shock appeared. The absence of democratic corporatism was also confirmed by a recent academic study (Thorhallsson, 2010).
To determine if Iceland had a social welfare system table 1.6 compares the small European states that are included in Katzenstein’s study and the United States with Iceland. In this table Switzerland is not classified as Katzenstein’s welfare state but the other states are. Table 1.6 shows that Iceland has the lowest social spending compared to all the other states (Organisation for Economic Co-operation and Development, 2019). Katzenstein expects that
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small states compensate their vulnerabilities with a social welfare system and democratic corporatism but Iceland clearly does not classify as Katzenstein’s model.
Table 1.6
Social spending as share from GDP
Year: 2006 2008 2010 Denmark 25,2% 27,1% 28,9% Netherlands 20,5% 21,4% 22,15 Norway 20,8% 21,1% 21,9% Switzerland 18,4% 18% 18,4% Iceland 15,9% 16,4% 17%
Note. Adapted from the Organisation for Economic Co-operation and Development (2019b). Social spending as
share from GDP.
Diverse economy
Table 1.7 shows that when the economic crisis started Iceland had a HH economy concentration index score of 0,1 which is reasonably close to 0. The lower the score, the lower the market concentration and the higher the economic diversity. Iceland is ranked 70 of the 170 countries on the Market concentration index ranking list (World Bank, 2018). This means that the Icelandic economy is averagely diversified and is not dominated by one particular sector.
Table 1.7
Iceland’s HH Economy concentration index score
Year HH score 2006 0,09 2007 0,10 2008 0,10 2009 0,09 2010 0,09
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Note. Adapted from World bank (2018). HH Market concentration index.
The case of Malta
The fact that a small state economy can be resilient has become evident in the case of Malta during the economic crisis. From 1990 until 2007 Malta showed significant economic development with a yearly average GDP growth of almost 4,2 percent (World Bank, 2019). Important sources of economic growth in Malta were tourism, manufacturing, and the Maltese finance sector (Galizia, 2016). In 2009 Malta’s economy saw a 2,5 percent decrease in GDP. This was the first GDP decrease Malta saw in almost 30 years (World Bank, 2019). A 2,5 decrease of GDP might seem negative but compared to the European average of 4,3 percent it showed that Malta’s economy was far more resilient than other European economies.
Social development & Civil unrest
Table 1.8 shows that Malta has a high social development. The life expectancy is higher in Malta than in most European countries, and mean years of schooling and the enrolment ratio is close to European average. Europe has a considerably above average level of social development
compared to other regions (Our World in Data, 2014). Malta scores above the European average on the indicator life expectancy, and considerably close to the European average on the other indicators. This shows that a high social development was present in Malta.
It should be noted that there was some civil unrest in Malta at the beginning of the economic crisis, but this was not significantly more than during other periods. The protest were about new energy tariffs and they were not well attended (Manwel, 2009). The strong
polarisation of Maltese society and the two-party system results in a civil climate where protest against the government are nothing unusual (Cini, 2002).
Table 1.8
Social Development Malta
Malta: European
Average:
Year Life expectancy in years Mean years of schooling (Primary) school enrolment ration Life expectancy In years Mean years of schooling (Primary) school enrolment ration 2007 80,2 9,9 94,4% 75,1 10,9 94,6%
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2008 80,4 10 94,4% 75,5 11,3 95%
2009 80,6 10,2 94,4% 75,8 11,7 95,3%
2010 80,9 10,3 94,4% 76,3 11,9 96%
Note. Adapted from The United Nations Development Programme. (2019). Human development Data (1990-2018)
Good governance
Table 1.9 shows that the quality of governance was good in Malta. Malta scored relatively high on all indicators compared to the 203 different countries that are included in the dataset. In 2008 Malta was ranked number 23 in the rankings of the average on all six indicators (World Bank, 2018). Therefore, one can clearly state the quality of governance in Malta was good at the beginning of the crisis. This is in line with the expectation that good governance increases economic resilience.
Table 1.9
Good Governance Malta
Year Voice of Accountability Political Stability Government Effectives Regulator Quality
Rule of Law Control of corruption
2007 90,9% 95,1% 83,9% 85,4% 92,3% 81,6%
2008 90,9% 95,2% 87,0% 86,4% 91,8% 81,6%
2009 87,7% 92,9% 84,2% 89,0% 90,5% 74,2%
Note. Adapted from the World Bank (2018b). Worldwide Governance indicators.
Macro-economic stability
Table 1.10 shows that before and at the beginning of the economic crisis Malta had an
unemployment rate somewhat above the natural rate of four to six percent, but not significantly higher. It furthermore shows that Malta’s inflation rate fluctuated around the healthy inflation rate of two percent. In 2007 and 2008 Malta’s government debt was slightly above the 62 percent European average. The following years it was far below the European average which was more than 75 percent (Eurostat, 2020). With an average unemployment rate of only 0,7 percent above the natural rate, an inflation rate that fluctuated closely around the healthy rate, and a government
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debt that was close to the European average, Malta can be considered as macro-economically stable.
Table 1.10
Macro-economic stability Malta
Year Unemployment Rate Inflation Government Debt Total %
of GDP 2005 6,9% 3% 70% 2006 6,7% 2,7% 64,5% 2007 6,5% 1,3% 62,3% 2008 5,9% 4,3% 62,6% 2009 6,8% 2,1% 67,6% 2010 6,8% 1,5% 67,55
Note. Adapted from the World Bank (2019). Databank.
Democratic corporatism & A Social Welfare System
To examine if democratic corporatism could strengthen economic resilience there is need to determine if democratic corporatism is present in Malta. The first indicator of democratic
corporatism, political-economic consensus, did not seem present in Malta. The interview with the former chairman furthermore shows that labour strikes were not an unusual phenomenon in Malta and that there was a large general worker strike in 2010 (Zarb, 2020, min. 15:00). This strike was by far the largest in 10 years (European Trade Union Institute, 2020). A high amount of strikes indicates little political-economic consensus.
Another clear indication for the absence of political-economic consensus is the existence of two major trade unions with different ideologies. There are two major trade unions in Malta, namely the GWU and the Voice of the Workers, they both present a large spectrum of workers. There are many political-economic differences between these two main labour unions and relationships are often tense (Fulton, 2015). The unions have strong affiliations with the political party that share their ideology. The former Chairman of the GWU said:
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‘We as a union are a left-wing union, and at that time there was a right-wing government. A left union and right government working together? You can imagine how that did not work’ (Zarb, 2020, min. 03:00).
This comment illustrates that there was a lack of political-economic consensus in Malta during that period.
Almost half of Malta’s workers are members of unions, which is a relatively high
percentage compared to other European countries (Fulton, 2015). However, interest organisations in Malta were not characterized as specialised, centralised and monopolistic peak organisations which is a characteristic for democratic corporatism. There are two major collective trade unions, but several occupations have their own independent union (European Trade Union Institute, 2016). All these unions have their own bargaining power and due to their ideological differences and policy disagreements relationships are often tense
Negotiations between labour and employer organisations in Malta are bilateral. The interview with the former chairman shows that, in general, the relationship between employer and labour organisations were good (Zarb, 2020, min. 02:00). Conflicts between employer and labour organisations were usually resolved by negotiations. The government did not have a role in the resolving of conflicts. The relationship between the government and the labour unions in Malta depends heavily on the type of government, because labour unions have strong party affiliations. The former chairman said:
‘Unfortunately, Policy involvement very much depends on the type of government in Malta, so we manage to find a way to discuss issues directly with the employers’ (Zarb, 2020, min. 12:00).
This means that there is no fixed council whatsoever that involves all interest groups and the government into structured negotiations, which is a common characteristic for democratic corporatism.
To determine if Malta had a social welfare system table 1.11 compares the small
European states that are included in Katzenstein’s study. In this table Switzerland is not classified as Katzenstein’s welfare state but the other states are. Table 1.11 shows that Malta spends far less on social welfare than all the other states. Katzenstein expects that small states compensate their
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vulnerabilities with a social welfare system and democratic corporatism but Malta clearly does not classify as Katzenstein’s model.
Table 1.11
Social spending as share from GDP
Year: 2006 2008 2010 Denmark 25,2% 27,1% 28,9% Netherlands 20,5% 21,4% 22,15 Norway 20,8% 21,1% 21,9% Switzerland 18,4% 18% 18,4% Malta 13,7% 13,6% 13,9%
Note. Adapted from World Bank (2019). Databank. And Eurostat (2020) Government Revenue and Expenditure.
Diverse economy
Table 1.12 shows that when the economic crisis started Malta had a HH economy concentration index score of 0,06 which is very close to 0. The lower the score, the lower the market
concentration and the higher the economic diversity. Furthermore, Malta is ranked 36th of the 170 countries on the Market concentration index ranking list (World Bank, 2012). This indicates that Malta’s economy is quite diversified and it is not dominated by one particular sector.
Table 1.12
Malta’s HH Economy concentration index score
Year HH score 2006 0,06 2007 0,06 2008 0,06 2009 0,04 2010 0,06
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Note. Adapted from World bank (2018a). HH Market concentration index.
Importance of Stability
Malta and Iceland are two cases that share a lot of similarities, but throughout the analysis it has become evident that the two cases are not quite the same. Table 1.3 and 1.8 show that Iceland had a higher social development than Malta and yet the crisis damaged the Icelandic economy far more than Malta’s economy. Furthermore, several sources show that despite the high level of social development in Iceland there was a great deal of civil unrest at the beginning of the crisis (Iceland Review, 2008; The Guardian, 2009; IceNews, 2009a; IceNews, 2009b; Reykjavik Grapevine, 2013), while civil unrest was relatively low in Malta (Manwel, 2009). These two reasons suggest that the expectation that a higher social development increases economic resilience of a small state is untrue, certainly in these two cases.
The good governance indicators in Table 1.4 and 1.9 show that before the crisis the governance in Iceland scored better on all indicators for good governance. When the crisis started Iceland scored slightly lower on the indicator political stability and regulator quality than Malta, but considering all indicators, there was still significantly better governance in Iceland.
Therefore, good governance cannot be the reason why Malta was more resilient than Iceland. This suggest that the expectation that good governance increases the ability to withstand an external economic shock is untrue.
A variable where both cases show an evident difference is macro-economic stability. Table 1.5 and 1.10 show that the indicators unemployment rate and government debt total were fine for both states, but a large difference can be seen in the inflation rates. Iceland’s inflation rate was already exceedingly high and unstable before the crisis. One of the main reasons for unstable inflation rate was Iceland’s own currency; the small country with its own Krona was already in trouble before the crash. News publications show that the Icelandic central bank was trying to fight the high unhealthy inflation rates and its negative effects even before the crisis (IceNews, 2007; Iceland Review, 2007). When the situation escalated and the three main Icelandic banks collapsed the highly overvalued Icelandic Króna devaluated tremendously, causing the inflation rate to skyrocket for at least two years straight. In terms of Iceland’s macro-economic stability,
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this was one of the most turbulent periods in Iceland’s history (Iceland Review, 2008; IceNews, 2008; The Irish Times, 2009; IceNews, 2009c; Iceland Review, 2010).
While Iceland was fighting the high inflation rate, table 1.10 shows that Malta was enjoying a relatively stable and natural inflation rate. With such an unstable inflation rate in Iceland it is evident that their macro-economic stability was low, while Malta’s was relatively stable. The expectation is that small states that show macro-economic stability are expected to have more economic resilience against the impact of an economic shock (Briguglio et al., 2009). In these two cases this seems true and it is very plausible that the presence of macro-economic stability in Malta was one of the reasons why Malta was more resilient against the economic shock.
Increasing Sectoral Dependence
Table 1.7 and Table 1.12 show that Malta had a significantly less concentrated economy than Iceland at the beginning of the economic crisis. While it should be noted that Iceland did not have a heavily concentrated economy, it did depend on fewer sectors than Malta. Furthermore table 1.7 shows that Iceland’s economy became slightly more concentrated in the run up to the crisis. In 2006 it scored a 0,9 and in 2007 a 0,10. This might seem insignificant, but in the Market
concentration index ranking list Iceland’s rank dropped from place 60 to 70 (World Bank, 2018). This is an indication that the Icelandic economy became more concentrated.
Before the crisis both states showed high economic growth, but in both countries this growth was produced by different sectors. This growth was produced by fewer sectors in Iceland than in Malta. Table 1.13 shows that from 2000 until 2007 only one sector grew in its share of Iceland’s GDP, while the other sectors’ shares decreased. In Malta three different sectoral shares increased and only one decreased. Table 1.13 shows that in Iceland the financial and business sector from 2000 until 2007 grew with more than nine percent in its share of the GDP. This was less than four percent in Malta. Iceland became increasingly dependent on the financial sector for economic growth, and due to the financial nature of this crisis Iceland was extra vulnerable. This shows that our expectation is true and that a state that heavily depends on a small variety of sectors for economic growth is less resilient (Bristow and Healy, 2018). The higher economic diversity of Malta compared to Iceland is one of the reasons why Malta was more economically resilient.
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Table 1.13
Gross value added as a percentage of GDP Iceland and Malta
Iceland Malta Year 2000 2007 2010 2000 2007 2010 Financial and business activities 19% 28,1% 24,3 17,5% 21,1% 22,1% Other service activities6 34,7% 29% 26,8% 39,7% 42,4% 46,5% Agriculture, fishing and water supply 12,3% 10,3% 11,6% 2,7% 3,5% 2.7% Manufacturing and Construction 21,9% 21,2% 21,5% 28,4% 19,1% 18,9% Wholesale and retail trade 12,1% 10,0% 16,4% 11,74% 11,75% 10,0%
Note. Adapted from Iceland Statistics (2004). Iceland in Figures 2004-2005, Iceland Statistics (2008). Iceland in Figures 2008-2009, Iceland Statistics (2011). Iceland in Figures 2011, National Statistics Office (2004). Malta in Figures 2004, And National Statistics Office (2011). Malta in Figures 2011.
‘Smaller’ States and Katzenstein
Malta and Iceland both did classified as Katzenstein’s model; there was no democratic corporatism or social welfare system present in Iceland or Malta. This means that this thesis cannot falsify the expectation that small states with democratic corporatism and social welfare
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systems are expected to compensate for vulnerabilities and create more resilience against an economic shock. However, the fact that Malta was resilient against this economic crisis does show that small states do not necessarily compensate their vulnerabilities with a social welfare system and democratic corporatism. Katzenstein furthermore suggests that small states without democratic corporatism and a social welfare system are more vulnerable to economic shocks (Katzenstein, 1985). Although this is true in Iceland’s case, this certainly was not the case with Malta.
CONCLUSION
By comparing Malta and Iceland in light of the economic crisis this thesis produced some interesting insights. A high social development does not necessarily strengthen a small state to withstand the negative effects of an economic shock and it did not seem to have a decreasing effect on the civil unrest in Iceland, unlike Briguglio (2014) expected. With a higher quality of governance in Iceland than in Malta it was expected by Briguglio et al (2009) that Iceland would be more resilient than Malta, however, this was not the case. This also means that good
governance does not necessarily strengthen resilience.
Furthermore, Malta and Iceland both did not fit Katzenstein’s model and therefore this thesis cannot conclude anything about the influence of democratic corporatism or a social welfare system on economic resilience. This thesis does show, however, that Katzenstein’s assumption that small states that fit Katzenstein’s model are more vulnerable is untrue.
The aim of this thesis was to find the reason why Malta was more resilient to the economic shock of 2008 than Iceland. Based on the analysis, the conclusion can be drawn that macro-economic stability and a more diverse economy were instrumental in Malta’s resilience against the economic shock. Briguglio et al (2009) expected that better macro-economic stability created more resilience and these two cases show that it did. High inflation rates in Iceland and stable ones in Malta, made Malta more macro-economically stable compared to Iceland. Another reason was the less concentrated economy in Malta. The literature suggested that more diverse economies would be more resilient, and these two cases show that this is correct. Iceland
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The literature about small states also suggests that a concentrated economy is a common problem for small states, which is true in Iceland’s case as shown by this thesis, in Malta’s case it also shows that a small state can be diverse enough to be resilient against an economic shock. Furthermore, it shows that if small states focus on increasing macro-economic stability and diversification of their economy their resilience will increase. It therefore can be expected that all small states that are macro-economically stable and have an economy that does not depend on a small number of sectors for growth will be far more resilient. This it shows which aspects small states, and likely also larger states, should focus on to be more resilient for the next economic crisis and avoid the Scandinavian nightmare, namely diversify the economy and focus on macro-economic stability. For example, a good choice for a small state like Iceland could be to join a larger currency to increase its macro-economic stability.
Future research is needed on the relationship between social development, civil unrest and resilience because their relationship seems somewhat vague, because despite the high social development in Iceland there was still a lot of civil unrest. The absence of Katzenstein’s model in Malta is interesting on its own, but it could furthermore suggest that maybe Malta has developed a system of corporate groups that creates resilience, which would be an interesting for future research.
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APPENDIX
Social Spending Malta Share of GDP%
2005 2006 2007 2008 2009 2010 Social spending in millions of Euro’s: 676,3 714,5 770,4 815,5 870,6 906,0 Social spending in millions of Dollars: 676,3 * 1,25 = 845,4 714,5 * 1,3 = 928,85 770,4 * 1,35 = 1040 815,5 * 1,5 = 1223,3 870,6 * 1,4 = 1218,8 906,0 * 1,35 = 1223.1 GDP in Millions of Dollars: 6395 6757 7881 8977 8528 8749 Social spending GDP share: 845,4 : 6395 * 100% = 13,2% 13,7% 13,1% 13,6% 14,3% 13,9%
Note. Data from World Bank (2018) Databank. And social spending Eurostat (2019) Database
Average Exchange rate, 1 Euro for Dollar (Dollarkoers, 2010):
2005: 1,25 2006: 1,30 2007: 1,35 2008: 1,5 2009: 1,4 2010: 1,35
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Questionnaire Interview Democratic Corporatism and Social development
Floris Hagel, Universiteit Leiden
Democratic corporatism
1. How would you describe the organisation of interest’s groups in your country? 2. How would you describe the relation between the government, labour unions and
employer organisations in your country?
3. Are there a lot of conflicts between labour organizations and employer organizations or the government? – Follow up question if answered yes: How are these conflicts
expressed?
4. Were there more conflicts than usual during the start of the economic crisis or where there any notable conflicts?
5. How are conflicts over economic and social issues between employment organisations, labour unions and the government resolved in your country?
6. Did the economic crisis influence or change the way how conflicts were resolved?
7. Do labour unions, or other interest groups, have a say in the creation of new government policy that relates to them?
8. Do you think that the relationship and the structures between employer organisations, trade unions and the government had any influence on the impact of the economic crisis in your country?
Social development
9. Many countries experienced the years 2008 until 2010 as the peak years of the economic crisis, would you say that there was any civil or industrial unrest in your country during this period?
10. Do you think that during the economic crisis the presence of civil or industrial unrest, or perhaps the absence of civil or industrial unrest, had any influence on the functioning of the economy in your country?
